Part 5 : is faster inflation for 2020 being under-estimated?
Markets appear to be under-estimating the risk of US inflation gathering significant pace.
Although currently still low, for the past six months, the Fed’s preferred inflation measure has been progressing at a rate slightly exceeding 1.5%. Inflation has been pulled down by several specific factors such as health insurance costs, but even the more refined inflation measures are showing price rises to be moderate and below their 2005–07 levels. Inflation expectations are also low, sitting at less than 2% for the next eight years.
Although it is difficult to see inflation breaking higher, history has shown that the economy can follow non linear patterns. During the extended period of low unemployment in the sixties, inflation only started to rise in 1966. The fall in unemployment to below 4% prompted a sharp acceleration in inflation, which shot up from approximately 1% to almost 5% in the space of three years.
How will the central banks and bond markets react if inflation starts to accelerate? If recent central bank statements are anything to go by, the initial reaction may be not to take any action. How bond markets would react to a delayed response from the Fed is unclear, but the current term premium [1] provided by 10-year bonds is offering little in the way of protection from a sharp readjustment in short-end interest rates.
[1] Term premium: the additional amount that investors receive for duration risk, which in turn is linked to the average life of the bond.
See also :
Market outlook S1 2020 | How much upside in risky assets after their stellar 2019?
The opinion expressed above is dated January 2020 and is liable to change. Latest available data is used.
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